Troubled Ass Relief Program (Tarp)

As the precipitous drop of the Dow Jones index of industrial stocks to the
8600 level on Thursday shows, the $700 billion bailout is an exercise in futility.
The rescue effort administers one wrong medicine after another. Shunting rotten
assets to the balance sheet of the central bank is not the way to go. Consolidating
banks through forced mergers is not the way to go. Cutting interest rates is
not the way to go. These measures make the problem worse, not better.

All the remedies to check the burgeoning credit crisis that have been proposed
or put into effect are based on misdiagnosis. This is not a sub-prime crisis
or a real estate crisis. It was not caused by loose lending standards, or by
the banks recklessly and aggressively increasing their assets.

This crisis was caused by shriveling capital ratios due to the destruction
of bank capital through 28 years of falling interest rates. As I have been
saying again and again, falling interest rates destroy capital by increasing
the liquidation value of debt -- an insidious process that has been missed
by all other observers. Ignoring capital dissipation is possible only so long
as capital lasts. As soon as capital is exhausted, dissipation stops. There
is nothing left to dissipate. The problem at once becomes painfully noticeable.

The term 'liquidation value of debt' is self-explanatory, meaning the lump
sum that will liquidate it before maturity, should it be necessary in case
of a takeover, merger, shot-gun marriage, bankruptcy, or outright nationalization
of the banking system. The point is that when the rate of interest falls,
the liquidation value of debt rises. Why? Because the stream of interest
payments is now discounted at a lower rate of interest. Therefore at maturity
it will fall short of liquidating the debt.

Here is a familiar example. When the rate of interest falls, the market immediately
bids up the price of bonds. This is the same to say that the liquidation value
of the debt underlying the bond is raised. Debtors wanting to liquidate their
bonded debt before maturity are not let off the hook on the same terms. The
market demands more than the pound of flesh originally agreed upon for releasing
the debtor from his bond. This example clearly shows that a fall in the
rate of interest, far from alleviating the burden of debt, aggravates it.

Bank capital is debt, and it has been eaten away by persistently falling interest
rates. Impairment of capital has been ignored and, after 28 years of negligence,
the global banking system now stands denuded of capital. Those shareholders
who can read balance sheets see through the fancy values banks are putting
on their assets, and they dump the stock before bank capital goes all the way
to zero.

The only way this crisis can be resolved is through recapitalizing the banks with
gold. Contrary to Keynesian propaganda, gold is not a barbarous relic.
It is not for decoration purposes. Nor does gold serve for the purpose of
window-dressing in the balance sheet. Gold is unique among financial assets
in that it has no counterpart as a liability in the balance sheet of others.
It follows that gold, and gold alone, will survive any consolidation of bank
balance sheets. Gold will not be netted out like paper assets are in case
of mergers, acquisitions, and takeovers, or the nationalization of the banking
system.

The fatal weakness of the present rescue effort is precisely this: consolidation
of banks, just as consolidation of the derivatives monster, far from stopping
the rot, will accelerate it. For example, if you consolidate the derivatives
monster, claims and counter-claims through credit-default swaps will cancel
out, and all risks will be exposed as being uncovered. Recapitalization with
more fiat money will not work. It takes something more solid than irredeemable
promises to pay. It takes gold.

Unfortunately our political leaders and policy-makers are lacking the moral
fortitude to admit that they have been wrong all along about gold and its role
in the financial system. Nor do they have the wisdom to realize that in cleaning
up the train wreckage they have to go back all the way to the point where the
train was derailed: to the insane decision to discard gold from the monetary
system in 1971. Politicians and their academic sycophants will stick to their
pet-rock, TARP, the Troubled Ass Relief Program (if you pardon my pun of cutting
off the tail of the word 'asset'). This is their cover-up of the fact
that the credit-crisis is their own making.

The first of the Twin Towers, the Derivatives Tower of Babel, has now toppled,
although you cannot see it yet as the dust is still settling. The toppling
of the second, the Debt Tower of Babel, will follow in due course -- unless
banks are recapitalized with gold with all deliberate speed.

The collapse of the Debt Tower of Babel would spell a disaster of the first
magnitude, adversely affecting everybody. It would trigger the Great Grand
Depression of the twenty-first century, making the Great Depression of the
twentieth look mild in comparison.

Calendar of events:

New York City, October 16, 2008Committee for Monetary Research and Education, Inc., Annual Fall Dinner.
Professor Fekete is an invited speaker. The title of his talk is:The Mechanism of Capital Destruction.
Inquiries: cmre@bellsouth.net

Santa Clara, California, November 3, 2008Santa Clara University, hosted by the Civil Society Institute
Professor Fekete is the invited speaker. The title of his talk is:Monetary Reform: Gold and Bills of Exchange.
Inquiries: ffoldvary@scu.edu

San Francisco, California, November 4, 2008Economic Club of San Francisco
Professor Fekete is the invited speaker. The title of his talk is:The Revisionist Theory and History of the Great Depression -- Can It Happen
Again?
Inquiries: ifkbischoff@yahoo.com

Canberra, Australia, November 11-14, 2008Gold Standard University Live, Session Five. This is the last session
of GSUL since our sponsor, Mr. Eric Sprott of Sprott Asset Management, Inc.,
has withdrawn his support saying that in his opinion the results do not justify
the expenditure. Come along and judge for yourself. This 4-day seminar is a Primer
on the Gold Basis -- Trading Tool for Gold Investors, Marketing Tool for Gold
Miners, and Early Warning System for Everybody Else.
A more detailed description of this seminar is found at the end of my article Cut
Off Your Tail to Save My Face!September 1, www.professorfekete.com
Inquiries: feketeaustralia@yahoo.com

In view of the extraordinary events unfolding in world finance
and on the banking scene right now, there will be an extra meeting to answer
questions from participants and to have a discussion from our distinctive point
of view, namely, that this is not a sub-prime crisis, not even a dollar crisis. This
is a gold crisis that cannot be solved by continuing to muzzle gold.

Canberra, Australia, November 15, 2008Panel Discussions:The chickens of 1933 and 1971 are coming home
to roost and take out bank capital.
Inquiries: feketeaustralia@yahoo.com

Disclaimer and Conflicts
The publication of this letter is for your information and amusement only.
The author is not soliciting any action based upon it, nor is he suggesting
that it represents, under any circumstances, a recommendation to buy or sell
any security. The content of this letter is derived from information and
sources believed to be reliable, but the author makes no representation that
it is complete or error-free, and it should not be relied upon as such. It
is to be taken as the authors opinion as shaped by his experience, rather
than a statement of facts. The author may have investment positions, long
or short, in any securities mentioned, which may be changed at any time for
any reason.